The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.

The New York Fed engages with individuals, households and businesses in the Second District and maintains an active dialogue in the region. The Bank gathers and shares regional economic intelligence to inform our community and policy makers, and promotes sound financial and economic decisions through community development and education programs.

The 2007-09 financial crisis exposed weaknesses in the design of the U.S. tri-party repo market that could rapidly elevate and propagate systemic risk.

A study of the market identifies the collateral allocation and unwind processes as two key mechanics contributing to the market’s fragility and delaying reform efforts.

One problem stems from the considerable amount of intervention by dealers to allocate collateral, which can slow processing and has been a significant obstacle to market reform.

A second problem is associated with reliance by dealers on intraday financing to “unwind,” or settle, expiring repos; the financing required creates potentially perverse dynamics that increase market fragility and financial system risk.

The authors conclude that by streamlining the collateral allocation process and eliminating the time gap associated with the unwinding of repos, market fragility and financial system risk could be reduced.

The study serves as a useful primer on the issues and mechanics that have contributed to the tri-party repo market’s fragility and impeded industry reform efforts.

About the Authors

Adam Copeland is a senior economist at the Federal Reserve Bank of New York; Darrell Duffie is the Dean Witter Distinguished Professor of Finance at Stanford University; Antoine Martin is an assistant vice president and Susan McLaughlin a senior vice president at the Federal Reserve Bank of New York.

Disclaimer

The views expressed in this summary are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.